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PLCM > SEC Filings for PLCM > Form 10-K on 21-Feb-2014All Recent SEC Filings

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Form 10-K for POLYCOM INC


21-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES. EXCEPT FOR HISTORICAL INFORMATION, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. WHEN USED IN THIS REPORT, THE WORDS "MAY,"
"BELIEVE," "COULD," "ANTICIPATE," "WOULD," "MIGHT," "PLAN," "EXPECT," "WILL,"
"INTEND," "POTENTIAL," "OBJECTIVE," "STRATEGY," "GOAL," "SHOULD," "VISION," "DESIGNED," AND SIMILAR EXPRESSIONS OR THE NEGATIVE OF THESE TERMS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING STATEMENTS, INCLUDING, AMONG OTHER THINGS, STATEMENTS REGARDING OUR ANTICIPATED PRODUCTS, CUSTOMER AND GEOGRAPHIC REVENUE LEVELS AND MIX, GROSS MARGINS, OPERATING COSTS AND EXPENSES AND OUR CHANNEL INVENTORY LEVELS, INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE FUTURE RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS" IN THIS DOCUMENT, AS WELL AS OTHER INFORMATION FOUND ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-K.

Overview

We are a global leader in open, standards-based unified communications and collaboration ("UC&C") solutions for voice, video and content collaboration solutions. Our solutions are powered by the Polycom® RealPresence® Platform, comprehensive software infrastructure and rich application programming interfaces ("APIs") that interoperate with a broad set of communication, business, mobile, and cloud applications and devices to deliver secure face-to-face video collaboration across different environments. With Polycom® RealPresence® collaboration solutions, from infrastructure to endpoints for all environments, people all over the world can collaborate face-to-face without being in the same physical location. Individuals and teams can connect, communicate, and collaborate through a high-definition visual experience from their desktops, meeting rooms, classrooms, home offices, mobile devices, web browsers, and specialized solutions such as video carts for healthcare applications. By removing the barriers of distance and time, connecting experts to where they are needed most, and creating greater trust and understanding through visual connection, we enable people to make better decisions faster and to increase their productivity while saving time and money and being environmentally responsible.

We sell our solutions globally through a high-touch sales model that leverages our broad network of channel partners, including distributors, value-added resellers, system integrators, leading communications services providers, and retailers. We manufacture our products through an outsourced model optimized for quality, reliability, and fulfillment agility.


We believe important drivers for the adoption of collaboration solutions include:

· UC&C solutions, including voice and video offerings, as a preferred method of communication,

· increasing presence of video on desktop and laptop devices,

· growth of video-capable mobile devices (including tablets and smartphones),

· growth of Microsoft Lync in the corporate environment and the resulting impact on sales of Polycom's Lync-compactible voice and video devices,

· expansion of business applications with integrated web-based video and content collaboration,

· virtualization and the move to private, public, and hybrid clouds,

· adoption of UC&C by small and medium businesses,

· growth of the number of teleworkers globally,

· new pricing models and options for video delivery, including subscription-based software pricing and as-a-service offerings,

· emergence of Bring Your Own Device (BYOD) programs in businesses of all sizes, across all regions,

· demand for UC&C solutions for business-to-business and business-to-consumer communications and the move of consumer applications into the business space, and

· continued commitment by organizations and individuals to reduce their carbon footprint and expenses by choosing video collaboration over travel.

We believe we are uniquely positioned as the UC&C ecosystem partner of choice through our strategic partnerships, support of open standards, innovative technology, multiple delivery modes and customer-centric go-to-market capabilities.

Total revenues for 2013 were $1.4 billion, a decrease of $24.2 million, or 2%, from 2012. On a year-over-year basis, our total product revenues declined while service revenues increased in all of our segments. The overall decrease in product revenues was primarily a result of lower sales of our UC group systems and UC platform products, partially offset by an increase in product revenues from UC personal devices products. The increase in service revenues was driven primarily by increased maintenance revenues on a larger installed base and increased maintenance service renewals year-over-year.

From a segment perspective, our Americas, EMEA, and APAC segment revenues accounted for 50%, 25%, and 25%, respectively, of our revenues in 2013. Our EMEA and APAC segment revenues decreased by 2% and 6%, respectively, while our Americas segment revenues increased by 1% in 2013 as compared to 2012. On a year-over-year basis, product revenues declined and service revenues increased across all our segments. See Note 17 of Notes to Consolidated Financial Statements for further information on our segments, including a summary of our segment revenues, segment contribution margins, and segment gross accounts receivable. The discussion of results of operations at the consolidated level is also followed by a discussion of results of operations by segment for the year ended December 31, 2013.

We believe the decline in revenues in 2013 was due to several factors, including a company and industry transition from point products to solution selling which resulted in some customers requiring additional time to consider a more comprehensive UC&C strategy versus point product or end point only deployments; slower public sector spending in North America; lower revenues in our EMEA segment impacted by economic conditions in Europe; and continuing slowdown of government spending and softer demand in other key geographies such as China and India. Further, our product revenues have decreased year-over-year since the first quarter of 2012, driven by lower UC group systems products, primarily group video products, and lower UC platform products, primarily in our Americas segment. We expect this trend to continue at least in the near term.

Operating margins decreased by 1 percentage point in 2013 as compared to 2012. The decrease in operating margin is primarily driven by a decrease in gross margin as a percentage of revenue, while operating expenses as a percentage of revenue remained relatively flat year-over-year. Gross margin decreased by 1 percentage point year-over-year, primarily as a result of lower revenues and changes in product mix toward lower margin UC personal devices products in 2013 as compared to 2012. Operating expenses decreased slightly in absolute dollars year-over-year, primarily due to decreased headcount-related costs and lower transaction-related costs being largely offset by higher restructuring charges.

During 2013, we generated approximately $168.4 million in cash flow from operating activities which, after the impact of cash received from a term loan, cash payments for share repurchases, and other financing and investing activities described in further detail under "Liquidity and Capital Resources," resulted in a $84.4 million net decrease in our total cash and cash equivalents.


Results of Operations for the Three Years Ended December 31, 2013

The following table sets forth, as a percentage of total revenues (unless indicated otherwise), consolidated statements of operations data for the periods indicated.

                                                               Year Ended December 31,
                                                         2013            2012           2011
Revenues
Product revenues                                             72 %            75 %           81 %
Service revenues                                             28 %            25 %           19 %
Total revenues                                              100 %           100 %          100 %
Cost of revenues
Cost of product revenues as % of product revenues            43 %            41 %           39 %
Cost of service revenues as % of service revenues            41 %            41 %           39 %
Total cost of revenues                                       42 %            41 %           39 %
Gross profit                                                 58 %            59 %           61 %
Operating expenses
Sales and marketing                                          32 %            33 %           30 %
Research and development                                     16 %            15 %           14 %
General and administrative                                    7 %             7 %            6 %
Transaction-related costs                                    -  %             1 %            1 %
Amortization of purchased intangibles                         1 %             1 %           -  %
Restructuring costs                                           3 %             2 %            1 %
Total operating expenses                                     59 %            59 %           52 %
Operating income (loss)                                      (1 )%           -  %            9 %
Interest and other income (expense), net
Interest expense                                             -  %            -  %           -  %
Other income (expense)                                       -  %            -  %           -  %
Interest and other income (expense), net                     -  %            -  %           -  %
Income (loss) from continuing operations before
provision for income taxes                                   (1 )%           -  %            9 %
Provision for (benefit from) income taxes                    -  %             3 %           -  %
Net income (loss) from continuing operations                 (1 )%           (3 )%           9 %
Income from operations of discontinued operations,
net of taxes                                                 -  %             1 %            1 %
Gain from sale of discontinued operations, net of
taxes                                                        -  %             3 %           -  %
Net income (loss)                                            (1 )%            1 %           10 %

Revenues

We manage our business primarily on a geographic basis, organized into three
geographic segments. Our net revenues, which include product and service
revenues, for each segment are summarized in the following table:



                                                                             Increase
                                                                          (Decrease) From
                               Year Ended December 31,                      Prior Year
   $ in thousands      2013             2012             2011           2013           2012
   Americas         $   694,522      $   689,099      $   693,288           1 %           (1 )%
   % of revenues             50 %             49 %             49 %
   EMEA                 338,035          345,723          347,703          (2 )%          (1 )%
   % of revenues             25 %             25 %             25 %
   APAC                 335,832          357,806          361,198          (6 )%          (1 )%
   % of revenues             25 %             26 %             26 %
   Total revenues   $ 1,368,389      $ 1,392,628      $ 1,402,189          (2 )%          (1 )%

Total revenues for 2013 were $1.4 billion, a decrease of $24.2 million, or 2%, from 2012. The overall decrease in revenues in 2013 from 2012 was due to decreases in product revenues of $51.4 million, or 5%, partially offset by increases in service revenues of $27.1 million, or 8%, in 2013 as compared to 2012. Product revenues decreased in 2013 primarily as a result of decreases in revenues from UC group systems and, to a lesser extent, decreases in UC platform revenues, partially offset by increased product revenues from UC personal devices. The increase in service revenues were primarily due to increased maintenance revenues on larger installed base and increased maintenance service renewals year-over-year.


From a segment perspective, our EMEA and APAC segment revenues decreased by $7.7 million, or 2%, and $22.0 million, or 6%, respectively, and our Americas segment revenues increased by $5.4 million, or 1%, in 2013 as compared with 2012. The overall decrease in revenues in 2013 was driven primarily by decreased revenues across many of our key geographic markets, including India, China, Germany, the Nordic countries, and Russia, partially offset by increases in the United States, Japan, the United Kingdom, and Australia. Product revenues decreased and service revenues increased across all segments in 2013 as compared to 2012.

Total revenues for 2012 were $1.4 billion, a decrease of $9.6 million, or 1%, from 2011. The overall decrease in revenues in 2012 from 2011 was due to decreases in product revenues of $95.6 million, or 8%, largely offset by increases in service revenues of $86.0 million, or 33%, in 2012 as compared with 2011. Product revenues decreased in 2012 primarily as a result of decreases in revenues from UC group systems, and, to a lesser extent, decreases in UC platform revenues, partially offset by increased product revenues from UC personal devices. The increases in service revenues were primarily due to increased maintenance revenues on a larger installed base and increased managed service revenues as a result of the HPVC business acquisition that we completed in the third quarter of 2011. Total revenues decreased across all segments in 2012 as compared to 2011. Our Americas, EMEA, and APAC segment revenues decreased by $4.2 million, $2.0 million, and $3.4 million, respectively, in 2012 as compared to 2011, a sequential decline of 1% year-over-year in each segment. The overall decrease was driven by decreased revenues across many of our key geographic markets, including the United States, Australia, Brazil, the Nordic countries, the Middle East/Africa and Turkey, India, Japan, and China. Overall, product revenues decreased and service revenues increased across all segments in 2012 as compared to 2011.

Cisco has informed us that it will end of life, and will therefore no longer resell, the IP conference phones they purchase from us. In 2013, we generated approximately $42.6 million in revenues from this relationship. We expect the remaining revenues from Cisco to be less than $5.0 million in 2014. We have been planning for the transition and are working to evolve the features and functionality of our VoIP conference phone portfolio to be interoperable in a Cisco environment.

In 2013, 2012, and 2011, one channel partner, ScanSource Communications, accounted for 16%, 14%, and 14%, respectively, of our total revenues. We believe it is unlikely that the loss of any of our channel partners would have a long-term material adverse effect on our consolidated revenues or segment revenues as we believe end-users would likely purchase our products from a different channel partner. However, a loss of any one of these channel partners could have a material adverse impact during the transition period.

In addition to the primary view on a geographic basis, we also track revenues by groups of similar products and services for various purposes. The following table presents revenues for groups of similar products and services:

                                                                              Increase
                                                                           (Decrease) From
                                  Year Ended December 31,                    Prior Year
  $ in thousands           2013            2012            2011          2013           2012
  UC group systems      $   904,923     $   956,153     $   971,753         (5 )%          (2 )%
  UC personal devices       219,103         180,939         175,673         21 %            3 %
  UC platform               244,363         255,536         254,763         (4 )%          -  %
  Total revenues        $ 1,368,389     $ 1,392,628     $ 1,402,189         (2 )%          (1 )%

UC group systems include all immersive telepresence, group video and group voice systems products and the related service elements. The decrease in UC group systems revenue of $51.2 million, or 5%, in 2013 from 2012 was primarily driven by decreased sales of our group video systems and immersive telepresence products and related services in all our geographic segments and, to a lesser extent, by decreased sales of our group voice systems products and related services in our EMEA and APAC segments, partially offset by increased sales of our group voice systems products and related services in our Americas segment. The decrease in UC group systems revenue of $15.6 million, or 2%, in 2012 from 2011 was primarily driven by decreased sales of our group video systems products and related services in all our geographic segments and, to a lesser extent, by decreased sales of our group voice systems products and related services in our Americas and EMEA segments. Those decreases were partially offset by increased sales of our immersive telepresence products and related services across all segments and, to a lesser extent, by increased sales of group voice systems products and related services in our APAC segment.

UC personal devices include desktop video devices and desktop voice products and the related service elements. The increase in UC personal devices revenue of $38.2 million, or 21%, in 2013 from 2012 was primarily due to increased sales of our desktop voice products and related services in all our segments, partially offset by decreased sales of our desktop video products and related services in all our segments. Overall, the increase in UC personal devices revenues was due in part to increased demand for our Microsoft® Lync® interoperable solutions and the continued adoption of VoIP technologies. The increase in UC personal devices revenue of $5.3 million, or 3%, in 2012 from 2011 was primarily due to increased sales of our desktop voice products and related services in our Americas and EMEA segments, partially offset by decreased revenues from desktop video products and related services in all geographic segments and, to a lesser extent, decreased revenues from desktop voice products and related services in our APAC segment.


UC platform includes our RealPresence platform hardware and software products and the related service elements. The decrease in UC platform revenue of $11.2 million, or 4%, in 2013 from 2012 was primarily driven by decreased sales of our UC platform products and related services in our Americas and APAC segments, partially offset by increased revenues in our EMEA segment. UC platform revenues remained relatively flat in 2012 as compared to 2011, primarily due to increases in revenues from our Americas and APAC segments being largely offset by decreased revenues from our EMEA segment.

Cost of Revenues and Gross Margins



                                                                                              Increase
                                                                                          (Decrease) From
                                               Year Ended December 31,                       Prior Year
$ in thousands                           2013           2012           2011           2013               2012
Product cost of revenues               $ 422,429      $ 426,369      $ 439,995             (1 )%              (3 )%
% of product revenues                         43 %           41 %           39 %            2  pts             2  pts
Product gross margins                         57 %           59 %           61 %           (2 ) pts           (2 ) pts
Service cost of revenues               $ 153,189      $ 142,827      $ 103,930              7 %               37 %
% of service revenues                         41 %           41 %           39 %           -                   2  pts
Service gross margins                         59 %           59 %           61 %           -                  (2 ) pts
Total cost of revenues                 $ 575,618      $ 569,196      $ 543,925              1 %                5 %
% of total revenues                           42 %           41 %           39 %            1  pt              2  pts
Total gross margin                            58 %           59 %           61 %           (1 ) pt            (2 ) pts

Cost of Product Revenues and Product Gross Margins

Cost of product revenues consists primarily of contract manufacturer costs, including material and direct labor, our manufacturing organization, tooling depreciation, warranty expense, freight, royalty payments, amortization of certain intangible assets, stock-based compensation costs, and an allocation of overhead expenses, including facilities and IT costs. Cost of product revenues and product gross margins included charges for stock-based compensation of $2.9 million, $3.6 million, and $2.5 million for the years ended December 31, 2013, 2012, and 2011, respectively. Cost of product revenues at the segment level consists of the standard cost of product revenues and does not include items such as warranty expense, royalties, and the allocation of overhead expenses, including facilities and IT costs.

Overall, product gross margins decreased by 2 percentage points in 2013 as compared to 2012, primarily due to lower than expected product sales and changes in product mix. Our UC Platform and UC Group Systems products typically have a higher gross margin than our UC Personal products, and overall product gross margins will fluctuate depending upon the product mix in any given period or geography. Product gross margin decreased across all of our segments in 2013 as compared to 2012, with the Americas having the largest decline due to the greater mix of UC Personal products compared to our EMEA and APAC segments. Product gross margins also decreased in 2013 as compared to 2012 as a result of increased amortization of purchased intangibles, which were partially offset by decreases in warranty expense and royalties. We also incurred higher costs in 2013 than in 2012 associated with increased excess and obsolete inventories as a result of product transitions.

Overall, product gross margins decreased by 2 percentage points in 2012 as compared to 2011, primarily due to lower than expected product sales and increased amortization of purchased intangibles and royalties, partially offset by lower warranty expense. From a segment perspective, product gross margins decreased in our Americas and APAC segments and increased in our EMEA segment in 2012 as compared to 2011.

Our inventory turns were 5.8 turns at December 31, 2013 as compared to 5.7 turns at December 31, 2012. Inventory turns decreased from 6.4 turns at December 31, 2011 to 5.7 turns at December 31, 2012, primarily as a result of higher inventory levels in 2012 as compared to 2011 due to an increase in UC group product inventories related to our new product introductions. Inventory turns in the future may fluctuate depending on our ability to reduce lead times, as well as changes in product mix and a mix of ocean freight versus air freight. Our inventory turns may also decrease in the future as a result of the flexibility required to respond to customer demands.

Cost of Service Revenues and Service Gross Margins

Cost of service revenues consists primarily of material and direct labor, including stock-based compensation costs, depreciation, and an allocation of overhead expenses, including facilities and IT costs. The majority of our service revenues are related to maintenance agreements on new product sales, the renewal of existing maintenance agreements, and managed services offerings. Cost of service revenues and service gross margins included charges for stock-based compensation of $5.9 million, $6.6 million, and $3.8 million for the years ended December 31, 2013, 2012, and 2011, respectively.


Overall, service gross margins remained relatively flat in 2013 as compared to 2012, primarily due to increased service revenues being substantially offset by increased cost of services. Service revenues increased by 8% in 2013 from 2012, primarily due to increased maintenance service revenues on a larger installed base and increased maintenance service renewals. The increase in direct spending costs was a result of increased headcount-related costs, as well as IT and facilities allocations, partially offset by decreased managed network costs. Our service organization headcount increased by 6% from December 31, 2012 to December 31, 2013. Service gross margins as a percentage of service revenue decreased in our Americas segment and increased in our EMEA and APAC segments in 2013 as compared to 2012.

Overall, service gross margins decreased by 2 percentage points in 2012 from 2011, primarily due to the lower margin managed services business we acquired as part of the HPVC acquisition in 2011. Direct spending costs increased primarily as a result of increased headcount-related costs, including stock-based compensation costs, as well as IT and facilities allocations as a result of a 21% increase in services organization headcount from December 31, 2011 to December 31, 2012. Service gross margins as a percentage of service revenue decreased in our EMEA and APAC segments, but were up in the Americas segment in 2012 as compared to 2011.

Total Cost of Revenues and Total Gross Margins

Overall, total gross margins as a percentage of revenue decreased by 1 percentage point in 2013 as compared to 2012, primarily due to decreases in product gross margins, as discussed under Cost of Product Revenues and Product Gross Margins. Total gross margins as a percentage of revenue decreased by 2 percentage points in 2012 as compared to 2011, due to decreases in both product and service gross margins, as discussed under Cost of Product Revenues and Product Gross Margins and Cost of Services Revenues and Service Gross Margins.

We expect gross margins to remain relatively flat in the near term as compared to 2013. Forecasting future gross margin percentages is difficult, and there are a number of risks related to our ability to maintain or improve our current gross margin levels. Our cost of revenues as a percentage of revenue can vary significantly based upon a number of factors such as the following:
uncertainties surrounding revenue levels, including future pricing and/or potential discounts as a result of the economy or in response to the strengthening of the U.S. dollar in our international markets, and related production level variances; competition; the extent to which new services sales accompany our product sales, as well as maintenance renewal rates; changes in technology; changes in product mix; variability of stock-based compensation costs; the potential of royalties to third parties; utilization of our professional services personnel as we develop our professional services practice . . .

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